First, there was LEAP. Then there was Infinite Banking, also known as Be Your Own Banker. Now it’s Bank on Yourself, by Pamela Yellen. All of these books, however, are basically marketing projects by and for people who sell life insurance for a living, and are designed to appeal to more affluent investors with some free cash flow and who have long term liquidity needs, over and above a desire for a permanent death benefit.
Here’s the pitch, in a nutshell:
Over the course of their lives, most people pay oodles of interest to creditors on all manner of loans, from mortgages to cars to credit cards to college loans. This lost interest – and the interest on that interest – represents a tremendous drain on individual wealth.
If, instead, you aggressively saved money within a certain kind of life insurance policy, you could fund these purchases from that policy – and pay the policy back, rather than the bank. While there are some technical issues with the phrasing, this is the functional equivalent of paying yourself for the loan, with interest. Thus, you are retaining the interest within the cash value of your own life insurance policy, rather than paying off the bank. The claim is that rather than enriching the bank, your payments go back to enriching yourself or your heirs, when the policy pays off at your death.
Meanwhile, the pitch goes, you also get all the other benefits of whole life insurance:
- A guaranteed tax-free death benefit for your beneficiaries (important!)
- Cash value that grows at a guaranteed minimum crediting rate, with no risk of market loss.
- Tax-free growth
- Tax-free withdrawals
- Tax-free loans
- Annual dividend payments, provided your carrier is a mutual insurance company, owned by policyholders.
Is it a scam?
No. It’s certainly not for everybody. There are a number of factors that have to be in place for the concept to work well. But it is not a rip-off or scam by a long shot, when properly set up.
The first large-scale attempt to market this concept in the age of modern media came about in 1980, with Robert Castiglione’s founding of LEAP, Inc., and the publication of his book, LEAP – The Lifetime Economic Acceleration Process: The Key to Financial Success. Castiglione’s book, like Be Your Own Banker and Bank On Yourself, attempts to make the case for using life insurance in this way in laymen’s terms, free of technical language – and, alas, sometimes free of detailed analysis of the math involved.
But the concept was nothing remotely new – even in 1980. In fact, the roots of this strategy go back generations – at least prior to the Civil War. Here’s how it worked, in practice:
Farmers have always struggled with extreme seasonality of cash flows. It is the nature of the business. Farmers would generally have to borrow money to buy farmland. Then they would have to borrow more money to plant, and to have money to live on while they paid their mortgage, paid their laborers, if any, and waited for the harvest. At harvest time, if crops were good, they took their crops to market, and used the money to pay off the debt on their seeds and labor expenses. Meanwhile, a portion of their mortgage was paid down.
Remember, the term ‘mortgage’ comes from the same root as morte, or death. We are spoiled now, and are used to paying off a mortgage well before we embark on a lengthy retirement. In those days, people frequently did not live beyond their mortgages. Instead, rather than risk losing the family farm, the family would buy life insurance. If the farmer died before the mortgage was paid off, the life insurance company would pay the death benefit, and the farmer finally ‘bought the farm’ from the bank – which is where the term comes from.
Keep in mind that this was in the days before we had index funds, and before we even had mutual funds as we know them.
The system worked well for farmers, shippers, storekeepers who sold to farmers on credit pending the harvest, and other people with uneven cash flows: If they saved aggressively within a life insurance policy, the got a death benefit, and a ready source of liquidity from loans from the life insurance policy. And since the policy was ultimately secured by the death benefit, it was a safe loan from the point of view of the insurance company: It also meant that if there were a poor harvest, the farmer didn’t risk bankruptcy or foreclosure if he couldn’t pay back the loan right away. He could wait a year or two, in a pinch.
He still had a mortgage with the bank, but there were usually no car payments and very little consumer credit to worry about. Ultimately, however, the concept was the same: Using the cash value in a permanent life insurance policy as a short- and medium-term source of liquidity and financing.
Once the farm was paid off, the next generation didn’t have a mortgage anymore. So the policy could be tapped to buy more land, or to buy a new tractor or combine, build a new house, or anything else they wanted to do.
While little understood in popular media, the concept has been passed down from farmers to a wide variety of other businesses who use COLI, or company-owned life insurance, as a source of capital to fund operations, pay bonuses, or any number of other uses.